Steps for small business owners to take upon receiving an audit notice from the IRS
It is an unfortunate reality, but there is always a chance that a small business owner will face an IRS audit. The IRS website states, “An IRS audit is a review/examination of an organization's or individual's accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.” Two ways that small business owners can be selected for an audit include random selection/computer screening and related examinations (i.e., a tax return could be selected by IRS when it has similar issues to other returns that were audited). The IRS will conduct an audit three different ways: by mail, in-person interview at an IRS office (office audit), and in-person interview at taxpayer’s home, place of business, or accountant’s office (field audit).
Small business owners (especially sole proprietors) already have many responsibilities (personal and professional) and countless tasks to complete so the thought of receiving an audit notice from the IRS can be overwhelming given the uncertainty of the IRS audit process. Contrary to widely held belief, the experience of getting an audit notice is not as daunting and stressful as people think. With adequate preparation and professional help, the audit process can be very manageable. The audit process will be a minor inconvenience (i.e., spending time addressing the audit notice), but audits are a normal part of the IRS’ tax process and most of the time, they are resolved without any significant issues. Below, I list three steps to take from when the audit notice is received until it is time for the IRS audit.
Step #1: Review the audit notice and understand your rights
First, it is particularly important to carefully review the audit notice, which will include the type of audit, the tax year(s) being examined, and the specific areas of concern. Taking the time to review and understand the audit notice might take some time, but by understanding it well, it best prepares small business owners for the audit process. Once the audit notice is understood, a small business owner should start gathering documentation (e.g., invoices, bank statements, financial statements) that is relevant to the issue noted by the IRS.
Additionally, the IRS explains Your Rights as a Taxpayer so it is prudent for small business owners to get familiar with their rights. The IRS website states these rights that include:
“A right to professional and courteous treatment by IRS employees.
A right to privacy and confidentiality about tax matters.
A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
A right to representation, by oneself or an authorized representative.
A right to appeal disagreements, both within the IRS and before the courts.”
Step #2: Consider professional representation
“In situations that have a level of complexity, small business owners should consider hiring professional representation, which could include an attorney, Certified Public Accountant (CPA), or Enrolled Agent (EA), which can represent them before the IRS.”
There are situations where the audit notice is straightforward, but there are also situations where it can be complex for a small business owner. In situations that have a level of complexity, small business owners should consider hiring professional representation, which could include an attorney, Certified Public Accountant (CPA), or Enrolled Agent (EA), which can represent them before the IRS. Having professional representation can help improve the chance of obtaining a favorable outcome during an audit process as the tax professional can review documentation, provide expertise, and represent a small business owner during audit proceedings.
In addition to being a CERTIFIED FINANCIAL PLANNER™ professional, I am also an Enrolled Agent (EA) so as a tax professional, I can provide value to my small business owner clients with this type of professional representation. The IRS website states, “Enrolled agent status is the highest credential the IRS awards. Individuals who obtain this elite status must adhere to ethical standards and complete 72 hours of continuing education courses every three years. Enrolled agents, like attorneys and certified public accountants (CPAs), have unlimited practice rights. This means they are unrestricted as to which taxpayers they can represent, what types of tax matters they can handle, and which IRS offices they can represent clients before.”
Step #3: Respond to the IRS promptly and prepare for audit interview
Small business owners should respond to the audit notice within the specified time noted by the IRS. As with most things in life, completing items in a timely manner can only help the situation. Responding appropriately and on time is another way to increase the chance of a favorable outcome.
It is prudent for small business owners to diligently prepare for an audit (in-person interview) in advance by getting familiar with the tax laws applicable to the issue noted by the IRS. Also, it is important to stay focused when answering questions during audit proceedings (i.e., stay on the point by only providing answers to questions being asked).